Archive for Thursday, June 28, 2001

Fed running out of options

Sixth cut this year brings interest rates closer to core inflation rate

June 28, 2001

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Is Alan Greenspan's cattle prod running out of juice?

For a sixth time this year, the Federal Reserve chairman on Wednesday engineered an interest rate cut to try to revive the sagging U.S. economy, sending rates to their lowest level in more than seven years. But after five half-point interest rate cuts since January, the smaller slice signaled to many observers that the Federal Reserve is running out of room to operate.

The Federal Reserve's quarter-move point disappointed investors,
who wanted another half-point cut. The Dow Jones industrial
average, which had been up about 25 points before the Fed's
announcement Wednesday afternoon, closed down 37.64 at 10,434.84.
Specialist Patrick King pondered the numbers as he followed a quote
screen on the floor of the New York Stock Exchange.

The Federal Reserve's quarter-move point disappointed investors, who wanted another half-point cut. The Dow Jones industrial average, which had been up about 25 points before the Fed's announcement Wednesday afternoon, closed down 37.64 at 10,434.84. Specialist Patrick King pondered the numbers as he followed a quote screen on the floor of the New York Stock Exchange.

The Fed lowered its key overnight rate to 3.75 percent, just 1.25 percentage points above the core inflation rate. And while in theory policy-makers could run rates down to zero as happened in 1999 in the beleaguered Japanese economy most economists say 3 percent to 3.5 percent is about as low as the Fed will go, especially before seeing the full effect of the previous cuts.

With fingers crossed, economists and corporate managers say the stimulus from the first few rounds of rate cuts in January should start kicking in any minute now. Coupled with federal tax-cut rebate checks coming soon, they hope, the once-hot economy will get rolling again.

But, at the same time, the stock market is worse off than before the Fed started to cut rates, analysts are growing more pessimistic by the day about the prospect for a rebound in corporate profits this year, and economists worry that burdensome debt loads ultimately could stifle still-resilient consumer spending, a major engine of the record-setting expansion.

If, as time goes on, the economy doesn't respond, experts said, there may not be much more that can be done particularly by the Fed.

"Clearly now the Fed is moderating its pace," said William Sullivan, economist with Morgan Stanley Dean Witter in New York.

Absent more rate cuts, he said, look for the Fed to lower margin rates or to use the bully pulpit to push the Bush administration into softening its stance on a strong U.S. dollar, which hurts American companies that sell goods abroad.

Beyond that, economists say, Greenspan has few tricks at his disposal. The Fed's real power has dwindled since the days when it actually lent a lot of money to banks and more directly influenced home mortgage rates. Now, experts say, the bond market leads the way on long-term rates, with short-term rates following.

Another problem: The Fed has sharp tools for dealing with liquidity problems and currency crises, but those haven't been the problems for the current economy, said Mike Weiner, equities managing director for Banc One Investment Advisors Corp.




Declining interest rates can help or hurt, depending on your situation, said Jerry Samp, a financial consultant for A.G. Edwards & Sons Inc. in Lawrence.Help: People with home-equity loans or balances on credit cards, whose interest rates are expected to decline.Hurt: People with certificates of deposit. Buying a four-year CD in 1997 would have paid 7.5 percent interest. That same investment today would yield only 4 percent each year. For a $100,000 CD, that's an annual loss of $3,500.

Conversely, the current economic malaise derives from overinvestment in technology capital spending, not a lack of liquidity at banks, limiting the power of policy-makers to get the economy moving again.

Of course, historically, investors have been rewarded with higher stock prices after Fed rate cuts, Weiner said.

"But lower interest rates don't help a bankrupt technology company come back," he said.

And there's the rub. While the rate cuts ultimately may provide some stimulus for the economy, much of Corporate America has more pain to endure.

A few months ago, analysts still expected double-digit profit growth among companies in the Standard & Poor's 500. Now, according to First Call/Thomson Financial, estimates are for year-over-year declines until the fourth quarter and that hope is growing more tenuous by the day.

Noting the absence of language in the Fed's statement Wednesday indicating that it was taking "pre-emptive" action, Bank One economist Diane Swonk said the Fed is sending signals it is nearing the end of its rate-cutting cycle.

"Now there is concern about overshooting, and that could spook the market," she said.

In step, investors have been greeting rate cuts more cautiously than they did when they triggered the explosive reactions seen with the first few rate cuts.

"A sixth lump of sugar won't make your coffee any sweeter," said John Forelli, portfolio manager with Independence Investment LLC.

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